Definition
A red clause letter of credit is a documentary letter of credit that includes an advance-payment clause. It allows the beneficiary (seller) to draw an advance (usually a percentage of the LC amount) before shipment, under conditions stated in the LC text.
In practice, it’s used to fund pre-shipment costs when the seller needs working capital and the buyer is willing to support that via the LC structure.
When red clause LCs are used
Common use cases:
- sellers who need funds to purchase raw materials or start production
- commodity or seasonal supply chains where the seller’s financing is constrained
- deals where the buyer wants bank-managed control but still offers pre-shipment funding
Operator checklist (what to verify)
Before anyone draws an advance, verify:
- The LC text explicitly allows an advance (amount/percentage and conditions).
- Who pays fees and how advances are accounted for in the settlement.
- What evidence is required for the advance draw (receipts, undertaking, warehouse docs, etc.).
- Whether the advance reduces the available amount for final presentation.
- Deadlines (expiry and presentation periods) are still achievable.
Common mistakes
- treating the advance like a simple bank transfer (it’s clause-driven and auditable)
- drawing an advance without meeting stated conditions
- losing version control across amendments and advance draws